By Rita Cheng
Learn more about Rita on NerdWallet’s Ask an Advisor
The cost of higher education is a key part of the financial-planning picture for just about any family with kids. Millions of U.S. families are saving for college in the state-sponsored plans known as 529 plans, named for the section of the federal tax code that authorizes them. Here are a few important things to know about 529 plans.
Who can save money in a 529 plan?
Any U.S. citizen or resident alien age 18 or older can open an account in a 529 plan to save for higher education costs for a child, grandchild, godchild, younger relative or even him- or herself. Each state operates its own 529 plan, but you aren’t necessarily limited to investing in the plan in the state where you live. (Investing in your own state’s plan, however, may produce state tax benefits.) Money you put into a 529 can be invested only in the mutual funds or other options offered within that plan, which may be rather limited.
Can a non-U.S. citizen open a 529?
State 529 plan applications usually ask for the Social Security numbers of both the account owner (the person setting up the account) and the beneficiary. If you don’t have a Social Security number, contact the administrator of the 529 plan prior to establishing the account.
Some 529 plans may have residency requirements, such as mandating that either the owner or the beneficiary be a resident of the state offering the plan. In such cases, provided that the beneficiary is a resident, you may still be able to establish an account even if you’re not a U.S. citizen or resident.
How are these plans taxed?
Account owners don’t get a deduction on their federal income tax return for contributions to 529 plans. However, earnings on investments in the plan accumulate tax-free. Distributions from the plan are untaxed as long as the money is used to pay qualified higher education expenses. If it’s used for something else, you’ll pay tax on the earnings, plus a 10% penalty. States may offer additional tax benefits to residents who invest in their 529 plans.
What can the money be used for?
Money from 529 accounts can be used to cover tuition, fees and other expenses, such as room and board, at accredited colleges and universities in the U.S. and abroad. (The beneficiary is not required to attend a school in the state where the 529 plan is established.) Refer to the federal student aid website to determine which international institutions qualify.
Carefully review the requirements of the 529 plan to ensure that the particular educational institution that you or your beneficiary is considering is still an eligible institution. If funds are withdrawn from the plan to use at a non-eligible institution, investors must pay income tax and a 10% penalty on any earnings withdrawn.
Approved uses of 529 money are often referred to as “qualified withdrawals” and vary slightly from plan to plan. If contributions are used for non-qualified withdrawals, you may have to repay any state tax benefits you received, and additional taxes or penalties may be assessed.
As always, consider the state tax benefits, investment options, fees and expenses associated with 529 plans prior to making any investment decisions.
Image via iStock.
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